Friday Financial Restructuring Cap des Biches Ashanti Bogoso
Friday: Financial Restructuring Cap des Biches Ashanti. Bogoso Feng-Shui Copyright © 2003 Ian H. Giddy Financial Restructuring 1
Mt Cameroon Ecotours Copyright © 2003 Ian H. Giddy Financial Restructuring 2
Mt Cameroon Copyright © 2003 Ian H. Giddy Financial Restructuring 3
Leveraged Finance
Cost of the Deal lbocapacity. xls Copyright © 2003 Ian H. Giddy Financial Restructuring 5
LBO Financing NEWCO Cost of purchasing the business Copyright © 2003 Ian H. Giddy Senior debt $457 Mezzanine What securities? What returns? What investors? Equity $25 Financial Restructuring 6
Case Study: Cap des Biches (B) The LBO Proposal l Devise a recommended financing plan l GTI (owner) Buyers Copyright © 2003 Ian H. Giddy Other Investors Financial Restructuring 7
Cap des Biches (B) www. stern. nyu. edu/~igiddy/dakar Copyright © 2003 Ian H. Giddy Financial Restructuring 8
Corporate Financial Restructuring Prof. Ian GIDDY Stern School of Business New York University
What is Corporate Restructuring? Any substantial change in a company’s financial structure, or ownership or control, or business portfolio. l Designed to increase the value of the firm Restructuring l Improve capitalization Copyright © 2003 Ian H. Giddy Improve debt composition Change ownership and control Financial Restructuring 10
It’s All About Value l How can corporate and financial restructuring create value? Assets Fix the business Copyright © 2003 Ian H. Giddy Operating Cash Flows Liabilities Debt Or fix the financing Equity Financial Restructuring 11
Restructuring Figure out what the business is worth now Use valuation model – present value of free cash flows Fix the business mix – divestitures Value assets to be sold Fix the business – strategic partner or merger Value the merged firm with synergies Fix the financing – improve D/E structure Revalue firm under different leverage assumptions – lowest WACC Fix the kind of equity What can be done to make the equity more valuable to investors? Fix the kind of debt or hybrid financing What mix of debt is best suited to this business? Fix management or control Value the changes new control would produce Copyright © 2003 Ian H. Giddy Financial Restructuring 12
Corporate Finance CORPORATE FINANCE DECISONS INVESTMENT FINANCING PORTFOLIO CAPITAL M&A Copyright © 2003 Ian H. Giddy RISK MGT MEASUREMENT DEBT EQUITY TOOLS Financial Restructuring 13
Capital Structure: East vs West Intel VALUE OFTHE FIRM TPI Optimal debt ratio? DEBT RATIO Copyright © 2003 Ian H. Giddy Financial Restructuring 14
Fixing the Capital Structure Too little debt l Managers like to control shareholders’ funds l Underestimate the cost of equity Produces l Less discipline l Excessive cost of capital l Takeover risk Copyright © 2003 Ian H. Giddy Too much debt l Close control of equity l Easy money l Underestimate business or financial risks Produces l Risk of financial distress l Excessive cost of capital l Destroy operating value l Takeover risk Financial Restructuring 15
Fixing the Capital Structure: Distress Restructuring
The Three Excesses Labor l Capacity l Debt l Copyright © 2003 Ian H. Giddy Financial Restructuring 17
TPI’s Refinancing Asia’s biggest debtor l Almost $4 billion in foreign currency debt financing domestic revenues l Protracted rescheduling results in $360 million debt/equity swap l No change in management or effective control l Still needs $1. 2 billion new equity l Copyright © 2003 Ian H. Giddy Financial Restructuring 18
Debt-Equity Swaps Cosmetic or real? l Choices for company under siege l u. Raise new equity to pay off creditors Example: Iridium u. Give creditors equity in place of debt Example: Sammi Copyright © 2003 Ian H. Giddy Financial Restructuring 19
What Do Debt-Equity Swaps Do? Overleverage creates financial distress Actual or potential default Lenders take equity in lieu of repayment Lenders hold equity passively Lenders replace management Change of control means restructuring Existing management buys time n n n Copyright © 2003 Ian H. Giddy Lenders sell equity Financial engineering Bottom line “rationalization” Divestitures & outsourcing Financial Restructuring 20
What Are The Alternatives? l Key: Make the new securities attractive to: u. Existing lenders u. New bond investors u. New equity investors Copyright © 2003 Ian H. Giddy Financial Restructuring 21
The Financing Spectrum Equity Expected Return n n Residual returns after contractual claims Control through voting rights Senior Debt n n Returns independent of the value of the business Control through covenants Risk Copyright © 2003 Ian H. Giddy Financial Restructuring 22
The Financing Spectrum Expected Return Equity Preferred equity Convertible debt Subordinated debt Senior unsecured debt Senior secured debt Risk Copyright © 2003 Ian H. Giddy Financial Restructuring 23
The Financing Spectrum Expected Return Equity Preferred equity Convertible debt Subordinated debt Senior unsecured debt Asian bank NPLs Senior secured debt Risk Copyright © 2003 Ian H. Giddy Financial Restructuring 24
What Are The Alternatives? Asset-backed or cash flow-backed debt l Senior debt l Subordinated debt with upside participation l Subordinated debt with equity option l Preferred equity l Restricted shares l Common stock l Copyright © 2003 Ian H. Giddy Financial Restructuring 25
Subordinated High Yield Debt l l l “Junk bonds” – like equity, but allow increased financial leverage Tax advantage over equity Big market in USA (institutional investors) and increasing in Europe Leveraged loans favored by certain commercial banks Often used in connection with M&A and LBOs Behave like equity – and often have equity participation Copyright © 2003 Ian H. Giddy Financial Restructuring 26
Sub Debt -- Motivations Optimization of financial leverage l Regulatory-driven capital requirements l Rated asset securitizations (senior-sub structure in asset-backed securities) l Insider or supplier-credit subordination (eg in project finance) l Work-outs and restructurings (existing borrowers agree to seniority of new loans, to buy time) l Copyright © 2003 Ian H. Giddy Financial Restructuring 27
Sub Debt’s Big Problem: High Interest! Solutions l Deep discount subordinated debt l Subordinated debt with equity warrants l Convertible subordinated debt l Participating subordinated debt l Puttable subordinated debt Copyright © 2003 Ian H. Giddy Financial Restructuring 28
Preferred Equity Legally a form of equity l Claim senior to ordinary equity l May have fixed dividend, or may be “participating” l But cannot trigger liquidation if payment missed l Par value determines liquidation claim l Copyright © 2003 Ian H. Giddy Financial Restructuring 29
Convertible Preferred Used by venture capital firms l Permit investors to participate in growth l But give preference in liquidation if the venture fails l And disguise share value (tax!) l A variant – PERCS* give issuer right to convert into common stock l *Preferred equity redemption cumulative stock Copyright © 2003 Ian H. Giddy Financial Restructuring 30
Preferred Stock: Pros and Cons Advantages l No dilution of control l Dividends conditional on availability of earnings l Omission cannot force liquidation Copyright © 2003 Ian H. Giddy Disadvantages l Higher after-tax cost than debt l Lower return on equity l Limited investor interest Financial Restructuring 31
Restricted Stock: Pros and Cons Advantages l Overcome foreign control restrictions l Insiders retain control l If company well run, value of control may be low Copyright © 2003 Ian H. Giddy Disadvantages l Nonvoting stock trades at a discount l Dual-class recaps hurt stock price l May allow management to avoid needed reforms Financial Restructuring 32
The New Equity Option Key: Make the new equity attractive to: l Portfolio investors l u. Domestic u. International u. Reduce no!” l agency costs or we’ll “Just say Strategic/direct investors u. Domestic u. International u. Cede Copyright © 2003 Ian H. Giddy control or we’ll go elsewhere Financial Restructuring 33
The Difference l l l “The Ministry of Finance received a preferred share while investors received a preferred share and a warrant allowing them to purchase the ministry's share at a 13. 3% premium (equivalent to the cost of carry) during a three-year period. The preferred shares carry a 5. 25% dividend and full voting rights” "When institutions started buying the story, they bought the convertible bonds, the sub debt - you name it, they bought it. " Alternatives: Thai Farmers Bank: SLIPS, Bankok Bank: CAPs Copyright © 2003 Ian H. Giddy Financial Restructuring 34
Transparency and Disclosure l l A 275 -page prospectus, which provided a breadth and depth of information previously unseen in an Asian issue. "We went and looked back at US bank holding company offers - those that were US SEC Grade 3 compliant. We also went back and looked at a lot of the prospectuses for the recaps of US banks, like Mellon and Citibank. We looked at the level of disclosure they achieved and committed ourselves to exceeding that -- which SCB did. " Copyright © 2003 Ian H. Giddy Financial Restructuring 35
What Globally Mobile Investors Look At Macro Factors Structural Factors Firm-level Factors Copyright © 2003 Ian H. Giddy • Currency overvaluation • Capital restrictions • Acctg & disclosure requirements • IAS compliance • Bankruptcy regime • Creditor rights • Govt-corporate nexus • Trading infrastructure • Price-Value ratio, Sharpe ratio, EVA • D/E ratio • Currency & maturity mismatch • IAS conformity • Insider control • Objective research coverage • Trading liquidity Financial Restructuring 36
Fixing the Capital Structure: Distress Restructuring
Cap des Biches (C) The Creditors are Prowling Trouble! Reason The financing is bad Business mix is bad The company is bad Remedy Raise equity or Change debt mix Sell some businesses or assets to pay down debt Change control or management through M&A Copyright © 2003 Ian H. Giddy Financial Restructuring 38
Financially Distressed Firms Lose customers l Get less favorable terms from suppliers l Are forced to discount products l Reduce new investment to below the optimal level Example: Hynix (Korea) l Source: Altman (1984), Opler and Titman (1994) Copyright © 2003 Ian H. Giddy Financial Restructuring 39
When Default Threatens, Value the Company Copyright © 2003 Ian H. Giddy Financial Restructuring 40
Zombie, Inc Does it make sense to dissolve the company? l Is it better to sell the company? l How much debt can the company afford to have? l Assume you have been brought in as the new CEO-CFO team. What terms of restructuring can you propose to the banks? l Copyright © 2003 Ian H. Giddy Financial Restructuring 41
Debt Restructuring in Distress Can a debt restructuring create value? Assets Operating Cash Flows Copyright © 2003 Ian H. Giddy Liabilities Debt Equity Banks give up some creditor rights in exchange for equity Financial Restructuring 42
Example Earnings at Zombie Inc. , have suffered in recent years. The private company now faces a financial crisis, as a result of its possible inability to repay a principal repayment on its debt coming due in the next quarter. Copyright © 2003 Ian H. Giddy Financial Restructuring 43
Example The company faces a takeover, but management has made a restructuring proposal to its unsecured bank lenders, namely that they convert one half of Zombie's bank debt into equity at the current book value per share. Should the banks take the offer? Copyright © 2003 Ian H. Giddy Financial Restructuring 44
Example of Valuation: Before-and-After Copyright © 2003 Ian H. Giddy Financial Restructuring 45
Cap des Biches (C) l CDB, two years after the successful LBO, is having difficulty meeting its debt service obligations. The banks are putting pressure on management to make a restructuring proposal. u Can Cap des Biches afford to pay its required interest and principal this year? Next year? u What is the debt capacity of Cap des Biches Power Company? u Please suggest a way in which the debt could be restructured to keep the banks satisfied and keep the company alive. Copyright © 2003 Ian H. Giddy Financial Restructuring 46
Fixing the Capital Structure: Making Use of Cash Flows
Leveraged Finance Company has unused debt capacity Copyright © 2003 Ian H. Giddy n Takeover? n Share buyback? n Leveraged recapitalization? Financial Restructuring 48
Leveraged Recapitalization Strategy where a company takes on significant additional debt with the purpose of paying a large dividend (or repurchasing shares) l Result is a far more leveraged company -- usually in excess of the "optimal" debt capacity l After the large dividend has been paid, the market value of the shares will drop. l Copyright © 2003 Ian H. Giddy Financial Restructuring 49
Leveraged Recapitalizations l Motivations: u. Defensive u. Proactive u. Ownership l transition/liquidity Which produces what value? Copyright © 2003 Ian H. Giddy Financial Restructuring 50
Cap des Biches (D) CDB, after its debt restructuring, has achieved a turnaround. Net cash flows are now positive and steady, and the shareholders are looking for ways in which they can realize the benefits of their investments. l Should they pay a dividend, buy back shares, or sell the company? l Group report due by Wednesday 11 th June Copyright © 2003 Ian H. Giddy Financial Restructuring 51
What is Corporate Restructuring? Any substantial change in a company’s financial structure, or ownership or control, or business portfolio. l Designed to increase the value of the firm Restructuring l Improve capitalization Copyright © 2003 Ian H. Giddy Improve debt composition Change ownership and control Financial Restructuring 52
Copyright © 2003 Ian H. Giddy Financial Restructuring 53
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